Freddie, Fannie Can't Shake Credit Concerns

Shares of Fannie Maeand Freddie Machit fresh lows Thursday amid concerns that shareholders could be wiped out if the government is forced to rescue the two companies.

CNBC

The shares continued their fall even as Freddie Mac and Fannie Mae officials tried to relieve concerns about their capital position.

A managing director at Fannie Mae, Brian Faith, told CNBC that the company has raised more than $14 billion in capital since last November, including $7.4 billion in May.

"As our regulator has stated, and has reiterated in public statements this week, we are adequately capitalized. Our core capital position on March 31, prior to the May capital raise, was $42.7 billion, $11.3 billion more than our statutory minimum requirement," Faith said.

A Freddie Mac spokeswoman told Reuters that the lender has "absolutely" enough capital.

Shares of Fannie Mae , which is the largest provider of U.S. home funding, fell about 15 percent to $13.00 on the New York Stock Exchange, having earlier touched a 17-year low on fears over its capitalization.

As shares plunged the difference between the companies' credit spreads on less secure subordinated debt and safer senior debt of Fannie Mae hit a record Thursday amid a fresh wave of anxiety over solvency of U.S. mortgage giants.

Credit spreads on the subordinated debt of Fannie Mae and Freddie Mac are widening faster than on senior debt amid increased worries about the ability of the two major U.S. mortgage finance companies to get the capital they need to survive.

Stoking concerns, former St. Louis Federal Reserve President William Poole said the two major U.S. mortgage finance companies were insolvent and may need a U.S. government bailout, according to Bloomberg News.

The outlook was so dire that Bush administration officials were meeting with regulators to discuss contingency plans should they be unable to raise funds and support the worst housing market since the Great Depression, according to a report in The Wall Street Journal.

"There is a lot of fear about the solvency of these companies," said Tim Backshall, chief credit strategist at Credit Derivatives Research.

"The senior spreads are widening, but they are still being held back by the fact that the government has implicit guarantee, whereas the subordinated debt is a lot less likely to be taken care of in case of a credit event."

High Anxiety

Credit default swaps on subordinated Fannie Mae debt widened by 18 basis points to 240 basis points, or $240,000 to insure $10 million of debt for five years, while senior spread was little changed in afternoon trading at 80.5 basis points.

The difference between the two rose by 50 basis points this week as investors tried to profit from the market anxiety and hit a record of 160 basis points on Thursday, according to Backshall. That record was first set on March 14.

"There is a real solvency issue here and people are gambling on it, betting on it happening by using the differential" between senior and subordinated debt costs, Backshall said.

Another sign of investor concerns about the risk to subordinated debt is the inverted curve for protection costs. Typically long-term protection is more expensive than short-term protection, but the cost to insure Fannie Mae's and Freddie Mac's subordinate debt against default for one year is 300 basis points—higher than on five-year swaps, according to Phoenix Partners Group.